Gold News

Crushing the Yen

Japan's monetary experiment continues...

THE WISE SAGES of Ancient days used to say, "The fate of a Liar is that nobody believes him – even when he's speaking the truth!" Such is the predicament of Japan's propaganda artists, including the prime minister, the finance minister, and central bank chief, who are all trying to cover-up their boldest scheme yet: to crush the value of the Japanese Yen against the currencies of its major trading partners, writes Gary Dorsch at

On May 11, the finance chiefs of the Group of Seven (G7) gave Tokyo the green light to continue with its radical QE scheme, which has already led to a -24% devaluation of the Yen against the US-Dollar, and a -33% devaluation against the Euro, since market savvy traders first got wind of the plot in late November.

In an age when ruling coalitions of every political stripe distort the truth to promote their self-interests, it's hardly surprising that Japan's ruling LDP party is steadfastly denying that it's engaging in a "beggar thy neighbor" devaluation of its currency. By the same token, Tokyo's fraudulent claim that its economy is still plagued by a negative rate of inflation (deflation) is so wildly at odds with reality that it's routinely regarded with cynicism and disbelief.

On May 9, the US Dollar's exchange rate rose above the key threshold of ¥100 for the first time in four-and-a-half years, extending a 30% surge since mid-November. The US-Dollar's advance didn't stop at ¥100 – it quickly surged to ¥102 the next day. The sharp move is just the latest episode in the mad scramble to dump the Japanese Yen – as the BoJ unleashes its most radical scheme ever – "Big Bang" QE – designed to crush the Yen's exchange rate. It's already dragged the Bank of Australia and the Bank of Korea into a regional currency war with Tokyo, with the Asian central banks cutting their loan rates last week, and hinting at more to come, trying to cap the rise of the Aussie Dollar and the Korean Won against the Yen.

Tokyo's "shock and awe" would double Japan's monetary base from ¥135 trillion ($US1.4 trillion) to ¥270 trillion in two years. Publicly, Tokyo insists that its radical scheme to double in the basic Japanese money supply over a period of 21 months is purely about trying to end two decades of prolonged deflation. This will be achieved by stepped-up purchases of long-term Japanese government bonds (JGBs) , and lifting the average maturity of its holdings from three to seven years. The BoJ will buy ¥7 trillion of JGB's per month – the equivalent of 1% of gross domestic product (GDP) every month for the remainder of 2013, and 1.1% per month in 2014. Given that Japan's economy is one-third of the size of the US's, the scope of Japan's QE scheme is three times more potent than the Fed's QE scheme.

"Japan's stance is gaining broader understanding,"finance chief Taro Aso said at a joint press conference on May 11. 

"The BoJ isn't targeting currency rates, which are determined by the markets," added BoJ chief Haruhiko Kuroda. 

In Tokyo, Japanese PM Shinzo Abe added, "I'm not in a position to comment on an appropriate currency level. Basically, our policies are not aimed at weakening the Yen. Various factors are behind exchange-rate moves. Among them, monetary policy plays a major one." 

But he added "the BoJ's policy steps could indirectly result in a weaker Yen and boost share prices, and help to lift corporate earnings".

Here's Tokyo's sleight of hand – a devaluation of a currency, whether deliberate or just a side-effect of QE, is still a tactical devaluation. The goal of Japan's monetary policy is quite simple – boost the market value of the Nikkei-225 and Topix indexes by weakening the Yen's exchange rate. As noted in the Wall Street Journal, The G20 communiqué offered a message that "countries can continue to devalue their currencies so long as they don't explicitly say they want to devalue their currencies. This contradiction between economic word and deed shows the degree to which policymakers have defaulted to easy money as the engine of growth. The rest is commentary," the WSJ's editors wrote.

"This monetary easing is in an entirely new dimension," the newly installed BoJ chief Haruhiko Kuroda declared, following the bank's April 4 decision. Kuroda emphasized the break with history, repeatedly pointing to a graph showing the planned jump in the country's monetary base. 

"Incremental steps of the kind we've seen so far weren't going to get us out of deflation. I'm certain we have now adopted all policies we can think of to meet the 2% price inflation target."

And if prices did not rise as expected, the BoJ would not hesitate to step up the easing program, Mr Kuroda warned. This radical stance represents a big sea change from his predecessors, who were faulted for being too ready to pull back from QE.

Prior to Mr Abe's election victory in mid-December, the BoJ kept a relatively tight rein on the monetary base. Under the guidance of BoJ chief Masaaki Shirakawa, Japan's monetary base grew at 4% per year, on average, for the five-year period ending in December 2012. There was a brief spike in Japan's monetary base in March 2011, when the BoJ took emergency measures to protect the nation's banking system in the wake of a crippling earthquake and ensuing tsunami. The BoJ injected a total of ¥60.6 trillion Yen ($739 billion) into the Tokyo money markets, and increasing the monetary base by 23%. However, the short-term liquidity injections were allowed to fully expire – draining the excess liquidity.

However, since Nov 2012, Japan's monetary base has soared 11% to a record ¥150 trillion, and now stands 23% higher than a year ago. This time, nobody expects the latest increase in the money supply to be temporary or rolled back. The BoJ says it will increase the monetary base until it reaches a whopping ¥270 trillion. In turn, the tsunami of excess liquidity flowing from Tokyo is expected to crush the value of the Japanese Yen against its trading partners, while fueling bubbles in global stock markets, via the infamous "Yen Carry" trade, which could grow in size to more than $1 trillion of highly leverage bets.

For Tokyo, the nuclear option of central banking – QE – is working to crush the exchange rate of the Yen, whereas its past policies of direct interventions in the foreign currency markets, mostly failed. Nearly 21-months ago, Japan injected ¥4.5 trillion into the currency markets, and bought $58 billion in one day's work of intervention as it acted strongly to put a floor under the US$ at ¥76. Traders said the Bank of Japan intervened on behalf of the Ministry of Finance (MoF) on August 4, 2011, concentrating its firepower in the US-Dollar against the Yen. However, that intervention foray couldn't even lift the US Dollar much above ¥79. A few months later, in Nov '11, the US$ was sagging again, and tumbled to Tokyo's red line in the sand at ¥76.

Japan is estimated to have injected ¥8trillion on Oct 31 2011 alone, a daily record, and spent about ¥1 trillion in the days that followed in follow-up action probably intended to keep markets more on edge for fear of more big moves. The MoF admitted that it sold a record ¥9.1 trillion Yen and bought $115 billion in currency intervention in the month through Nov 28th, 2011. The MoF still has sizable ammunition for intervention – it has parliamentary approval to borrow up to ¥37 trillion to be used for future Yen-selling interventions. Although the US$ did rebound by ¥6 in Q'1 of 2012, to as high as ¥82.5 in March '12, the rally soon fizzled out. By June of 2012, the US$ had fallen back again to ¥77.

As a side note, on Mar 21 2011, corporate raider Warren Buffett made a bold prediction, saying that the devastating impact of the earthquake and tsunami to hit Japan's economy, was the kind of extraordinary event that creates a buying opportunity for shares in Japanese companies. 

"It will take some time to rebuild, but it will not change the economic future of Japan. Frequently, something out of the blue like this, an extraordinary event, really creates a buying opportunity. I have seen that happen in the US, I have seen that happen around the world. I don't think Japan will be an exception," said the 80-year-old "Sage of Omaha" known for his long-term investing strategy. Buffett was correct – a little more than two years later, the Nikkei 225 is surging towards the 15,000 level, up 56% from the 9,600 level that prevailed when Buffett made his prediction.

However, it was a very rocky road for the Nikkei-225's recovery. Buffett's bullish prediction was placed in great doubt in May of 2012, when the Nikkei-225 fell to the 8,542 level, capping a -10% decline for the month. Short selling of Japanese stocks accounted for 32% of the total value of shares traded in the Tokyo Stock Exchange. The Yen's strength against the US Dollar and against the Euro in 2011 was crushing the income of Japanese Multi-Nationals' earned from overseas. Sony earns 70% of its revenue outside Japan and Panasonic 48%. Japan's biggest makers of phones, televisions and chips – Sony 6758.T, Panasonic 6752.T and Sharp 6753.T lost a combined $17 billion for the fiscal year – the worst losses in their histories. Fitch Ratings lowered the debt ratings of both Sony and Panasonic one notch to BBB-, keeping both on negative outlook, while lowering the outlook on Sharp's BBB- to negative, and was poised to downgrade all three companies to junk status in the next 12 months.

However, it's a completely different outlook today. Thanks to Tokyo's shift to Big-bang QE – Japan's Nikkei-225 index has surged 75% higher since mid-November, reaching for 15,000, its highest level in five-and-a-half years. The earnings season is in full swing, and the Yen's fall enables Japanese exporters to earn more from foreign currency profits. On May 13, blue-chip exporters soared, with Panasonic jumping 7.6% higher after saying its operating profit will likely jump 55% this fiscal year. Hitachi <6501.T> surged 7.8% after it forecast a 18.5% jump in operating profit for this fiscal year. Every one Yen increase in the US Dollar's value leads to a 2.4% increase in Nissan Motor's operating profit and 3.3% at Toyota Motor. Overall, Nikkei-225 companies' operating profits are expected to rise 28% compared with a year ago, if the US-Dollar can stay near ¥100.

On April 22, Japan's central bank chief Kuroda reiterated that Japan's Big-bang QE scheme would continue until Japan achieves a 2% inflation rate. Mirroring Kuroda's views, Finance chief Taro Aso said the Yen's weakness is a "byproduct of QE," but the ultimate aim is to end deflation and boost economic growth. "My position is that the Yen's decline may have resulted from our policies, but the aim of our policies is to escape deflation. Yen weakness is a byproduct," he explained.

Crushing the value of the Yen is about the only mechanism that Tokyo has readily available in order to boost Japan's inflation rate to 2%. That's a pretty tall order, since Tokyo massages its inflation data, and uses fuzzy math to calculate its cost of living index. The methodology is completely under the control of Tokyo's financial warlords, and the inflation data is routinely rigged to show a perpetual pattern of deflation. Last week, Japan said its consumer price index was -0.9% lower in April, compared with a year earlier.

Once every five years, the Japanese government revises the basket of products used to derive its consumer price index to better reflect trends in household spending. Government apparatchiks routinely remove the goods and services that are increasing in price from the index, and replace them with goods and services that are falling in price. At the last revision in July '11, Tokyo shaved -0.75% off its CPI rate. Five years earlier, it shaved -0.50% off its CPI. In other words, the brazen BoJ could triple its money supply, before Tokyo would ever admit that its inflation rate has reached 2% that's common everywhere else in the world.

How long can Tokyo's financial warlords continue brainwash the Japanese public into believing that the bogeyman of deflation is still haunting its economy? No doubt, MoF apparatchiks will continue to fudge the official inflation numbers. However, the truth is – the Continuous Commodity Index, measuring the cost of a basket of 17-equally weighted commodities, is now trading 26% higher than a year ago, when priced in Yen. A further weakening of the Yen would only increase the cost of imported goods for Japanese consumers. Already, the cost for imported fossil fuels jumped 10% last year to ¥24 trillion, even before the US$ crossed ¥90. Be careful of what you wish for, since a higher cost of living can sap the disposable income of your citizens, and lift JGB yields, which in turn, can also cause an economic recession.

The BoJ chief sounded confident on May 11 that the central bank could prevent an upward spike in Japanese bond yields. "I do not expect a sudden spike in long-term bond yields. In the long-run, if the economy recovers and inflation heads towards 2%, we might see nominal interest rates rise but that's natural." 

The rigging of Japan's CPI data is to be expected, so JGB traders should only trust the actual prices in the global commodity markets for real-time clues about the future direction of inflation, and not rely on doctored-up government statistics.

Despite Kuroda's belief that the BoJ can easily continue to manhandle Japan's $10.5 trillion government bond market, some market investors are starting to question the wisdom of owning ultra-low yielding JGB's. On May 13, ten-year JGB futures price posted its biggest three-day drop in two-and-a-half years, and skidded to a one-year low. The Tokyo Stock Exchange briefly suspended JGB trading as a circuit breaker was triggered. The 10-year cash bond yield shot upwards to as high as 0.86%, extending its biggest surge in five years.

JGB yields initially plunged in a knee-jerk reaction to a historic low of 0.315% upon hearing the details of the BoJ's scheme to purchase of ¥7.5 trillion of JGBs each month, which might lead to a scarcity of bonds. But it did not take a single day for the market to reverse course. The 10-year yield is now more than 2.5-times as high as it record low of 0.315% hit on April 4th. As part of its two-year Big-bang QE, the BoJ bought ¥1.2 trillion of bonds on May 13, but that failed to stop the uptick in JGB yields to 0.86%. 

Still, for Nikkei bulls – there's no need to panic – as the 10-year yield is still comfortably below 1%.

If the Yen begins to plummet into a free-fall, Japan's competitors in China, Germany, Korea and the US might cry foul and demand that Tokyo either scale back its Big-bang QE operations or stop them completely. Otherwise, other central banks might push back against Tokyo in a full scale currency war, the likes of which the world has never seen before. However, Tokyo is confident it can prevent a free-fall of the Yen, and that it can carefully orchestrate a gradual devaluation, with verbal Jawboning exercises and utilizing its enormous war chest of foreign currency reserves, now totaling $1.26 trillion, and mostly consisting of US Dollars.  

Although Japan is supposed to refrain from using its foreign exchange reserves for purposes of direct intervention in the currency markets, according to the Feb 12 G20 communiqué, the renegade BoJ is expected to begin clandestine sales of US Dollars at higher levels, in order to keep a two-way market intact, and prevent a currency free-fall. Where would Tokyo try to cap the US Dollar's advance? On January 18, Koichi Hamada, the chief architect of "Abenomics," gave a subtle hint to reporters at the Foreign Correspondents' Club of Japan in Tokyo,saying the US Dollar can rise to ¥110 before excessive inflation risks kick in." If the Dollar goes above ¥110, there may be reason for worry, but at ¥100 or ¥95, it's OK."

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

Follow Us

Facebook Youtube Twitter LinkedIn



Market Fundamentals